How to Calculate Interest Rates on a CD

Calculate and Compare Investments Carefully.

Calculating interest rates on a certificate of deposit can be straightforward, depending on how often the interest rate is compounded. Bonds are calculated on a semi-annual basis. CD's are not. As a marketing issue, banks try to sell the highest rate of interest to attract customers. This article shows underlying methods used for any calculation of interest.

Things You'll Need

• calculator

Instructions

1. Read the fine print of the certificate of deposit and ascertain the rate of interest, the maturity and whether the interest is calculated daily, monthly, annually or at maturity. Know that banks usually compute interest using twelve months and each month is assumed to have thirty days. This is also called the 30/360 method. Ignore leap years or the shorter number of days in February.

2. Count the number of days remaining in the first month. Then count the remaining months and multiply by 30. For a certificate of deposit purchased on April 17 and due on December 31 of the same year the number of days would be 17 + (8 * 30) or 257 days. Assume the certificate of deposit is calculated at interest at maturity.

3. Find the coupon rate of interest of the bond. Multiply the interest rate by the number of actual days. Using the information above and a 6% interest rate you would multiply 6 times the fraction 257/360. Carry the fraction out 4 places to the right. In this case the math would be: (257/360) = .7138. .7138 * 6 = 4.283. The effective rate of interest earned would be 4.28%.

4. Multiply the effective rate of interest by the par amount invested. Assume $50,000 invested. 0428 * $50,000 = $2140 interest earned. The total proceeds due at maturity is $52,140. Remember that amounts, whether principal or interest, are only insured up to federal limits. These limits change from time to time. Know the limit of your investment before you make the investment.

5. Compute the interest differently if compounding is done more frequently. This can be a difficult process to employ without use of an advanced calculator. Use the Resource for an online calculator that calculates other reinvestment periods. The procedure described above would provide the minimum amount of interest you would receive.

Tips & Warnings

• Always assume that interest is calculated using 30 days per month with 12 months in a year.

Resources

• Calculator for Varying Interest Rate Compound Periods